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Morgan Stanley Offers 8-Year Notes Linked to Euro Swap Rates

July 20 (Bloomberg) -- Morgan Stanley is selling as much as 10 million euros ($12.9 million) of eight-year structured notes that are linked to euro-area interest rates.

The bonds pay a fixed 4.5 percent coupon in the first year, which steps up by 0.25 percentage point in years two, three and four, according to the term sheet. In the final four years, the securities pay eight times the difference between the two-year and 30-year euro swap rate up to a maximum 8 percent.

Bonds linked to swaps allow investors to bet on the future direction of interest rates. Morgan Stanley’s notes perform best the more the 30-year swap rate, the cost of exchanging fixed for floating interest payments, is above the two-year rate.

“The product is for retail investors interested in the possibility of high coupons in a low interest-rate environment,” said Joern Schiemann, a vice president at Morgan Stanley’s derivatives solution group for Germany and Austria.

The 30-year swap rate is 3.29 percent and the two-year rate is 1.42 percent. The coupon has a zero percent floor so if short-term rates rise above longer-dated ones, or invert, investors won’t incur a loss on their principle.

The difference between two-year and 30-year swap rates has averaged 1.34 percentage points in the past 10 years, according to data compiled by Bloomberg. By 2015, the two-year rate will be about 0.04 percentage point more than the 30-year rate, according to the forward rate curve.

“If we enter a rate hiking cycle in three years the curve will flatten,” said Matteo Regesta, an interest-rate strategist at BNP Paribas SA in London. “Investors may be enticed by the huge yields of this product in the short-term, which they can lock in, while they could lose in the longer-term. In that respect, the eight times leveraging factor provides a cushion to such risk.”

The initial target issuance size may be increased, depending on investor demand, according to Morgan Stanley. The deal is the third series of “Interest Expander” notes sold by the bank and will be listed on Germany’s Frankfurt and Stuttgart stock exchanges.

To contact the reporter on this story: Sarfraz Thind in London at Sthind3@bloomberg.net

To contact the editor responsible for this story: Paul Armstrong at Parmstrong10@bloomberg.net

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